MNI POLICY: ECB Optimists Cautioned Amid Ongoing Uncertainty

By Luke Heighton

     FRANKFURT (MNI) - Members of the European Central Bank's Governing Council

were cautioned not to adopt too "optimistic" a position on the euro zone's

economic outlook, the official account of January's decision-making meeting

shows, amid concern it could send premature signals it might raise rates.

     Downside risks, though predominating, had become less pronounced thanks in

part to the recent phase-one trade deal between the United States and China and

greater clarity on the United Kingdom's withdrawal from the EU following

December's general election.

     Global activity and trade were still "subdued," it was noted, but there

were some signs of a stabilisation "and even a possible pick-up" in activity,

along with indications that the Governing Council's September package was being

gradually transmitted to the economy.

     As a result, "it was felt to be important to acknowledge [...] positive

signs and care should be taken to avoid being too slow to change the risk

assessment. However council members were warned to be "careful" in communicating

"a more optimistic outlook [...] in order not to give rise to a premature

tightening of financial conditions."

     With inflation still "far away" from the ECB's target rate of close to, but

below 2%, "members agreed that policy had to remain highly accommodative for a

prolonged period of time," notwithstanding a "slight uptick" in underlying

inflation.

     In addition, "unresolved issues remained between the United States and the

EU as regards trade," while there remained the possibility of greater divergence

in the future trade relationship between the EU and the UK than previously

expected.

     Recent increases in the stock market did not seem to be related to an

improvement in earnings expectations, it was remarked, pointing to a possible

disconnect between buoyant financial markets and the continued subdued outlook

for the real economy.

     Although activity in the services sector had been "quite resilient," and

although there "might have been a bottoming-out in manufacturing," it was too

soon to conclude that the slowdown in growth in the services sector had stopped.

     The slowdown in employment growth was also highlighted, and it was noted

that risk of adverse spillovers from the continued weakness in the manufacturing

sector to other sectors of the economy still needed to be monitored closely.

     The implementation of the two-tier system for reserve remuneration,

designed to partially off-set the negative effects of negative interest rates

for banks, was judged to have worked well.

     Members were "encouraged" by the fact that HICP inflation excluding food

and energy was at its highest level for four years, "even without housing costs

fully represented in the inflation measures." It was also pointed out that the

risk of deflation had declined further.

     However, concern was expressed that the recent slight increase in

market-based measures of inflation expectations might be related to higher oil

prices, and that investment was being held back by international uncertainty

despite the low cost of borrowing.

--MNI Frankfurt Bureau; +49-69-720-146; email: luke.heighton@marketnews.com

--MNI London Bureau; +44 203 865 3829; email: jason.webb@marketnews.com

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